Q & A with America's real estate professor: Home warranties

Zillow Published: January 24, 2014 9:41 AM

Home Warranties

Q. What do you think about home warranty for rentals? Best regards. Azhar, San Diego, Calif.

A. I’m glad to see that you are a rental property owner now! I’ve been hearing more and more investors that use home warranties, which is quite a turnaround from a few years ago. I’ll note how these work and a few issues to consider.

A home warranty costs about $350-$500 per year. Many sellers provide a home warranty to a buyer at the sale in hopes that gives the seller a little extra protection in case an appliance or other item breaks. And some home warranty companies do a decent job servicing their policies, but some don’t do a good job. Home warranty companies, unfortunately, are some of the most complained about service providers for unsatisfactory service, but many have good experiences too. You just have to find the good ones!

The main issue to understand is that a home warranty doesn’t cover everything that could go wrong. Like any insurance policy, there are exclusions for some issues, plus there are items like pools or air conditioners that cost extra. Most policy buyers don’t read the policy and just assume, incorrectly, that everything is covered.

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So if you are going to buy a policy, make sure you understand what is covered and what is not covered. Due to the relatively low cost, I don’t see any issues with buying a policy for a year and seeing what you experience if you need to make a service call and how good a job the company does on that call. Make sure to fill me in on your experience next year.

1031 Exchange

Q. We are doing a 1031 exchange and will soon be selling property for about $2,100,000. We want to buy some rentals and thought about Texas, but taxes are insane. So we are considering California. My question to you is do you think buying four to five ready-to-go rental properties is a good idea and where do you think we should be looking, since with the 1031 exchange we have limited time to identify properties. Josh B., North of Los Angeles

A. Make sure to get good legal, accounting and 1031 exchange advice months before you close escrow on what you are selling. Identifying a property within 45 days that you can actually get under contract and buy is very tough. If you are trying to buy five properties, that’s even tougher. You need the buyer of your property to work with you and agree to close escrow once you have all the replacement properties under contract and moving close to closing escrow. Otherwise, good luck completing the exchange.

Regarding buying rental properties, rentals are hard work. If you folks are older, you may not want to deal with rentals. Having a management company might help some, but might not help that much. So make sure you want to be landlords. Also, you should buy properties near where you live. If you have to travel long distances to service the property – even if you have a management company – this can be very disrupting to your life and you might find that the properties are more of a pain than they are worth.

Think it through and make sure the money you will save on taxes from the 1031 exchange is best placed in a relatively risky and high-maintenance asset like rental properties. If it doesn’t make sense, find a better investment choice – which might not be real estate. Good luck!